If you did not read todays op-ed piece in the NYT by Professor Paul Krugman, it is definitely worth the read. In the piece, Professor Krugman questions the credibility of those that would even suggest that the Fed policies of the last few years are laying the ground work for higher inflation. He calls it the power of the inflation “cult”. Mr Krugman wonders why so many have adhered to a prediction that so far has failed to materialize. I won’t ruin it for you, but his general thesis is that those that would argue that endless bouts of Fed liquidity ultimately will lead to inflation are really arguing against government spending. In Professor Krugman’s view, those in the inflation camp are really opponents of social programs in disguise. As someone who never saw a government spending program he did not like, he should know. In fact, if you follow Professor Krugman’s views in the NYT, he feels quite strongly that the Fed has not gone far enough to cure everything that ails the U.S. Economy. Much like those that he criticizes, Professor Krugman constantly is pressing for more of the same, while completely ignoring the possibility of unintended consequences. Professor Krugman also fails to mention that this sea of liquidity on which the global economy currently resides has been fueled by not only the Fed, but by every other major Central Bank. As someone who puts such credence in the powers of Central Banks, one would think that Professor Krugman would at least give some deference to the possibility that they will ultimately get what they want (higher inflation).
Category: Bond Market
We were somewhat surprised to see a tag line in the FT today denoting the shale industry as being “Fed Resistant”. What a sad commentary on responsible Central Banking. The tried and true market adage used to be ” Don’t fight the Fed”. That might have to be amended however to ” Don’t let the Fed fight you”. Central Bank activity has become so aggressive and pro-active over the past several years, that a simple unwinding of this hap hazard strategy will virtually ensure that those on the other side of this mis-pricing will feel the brunt of this realignment. We have been very upfront about those areas of the market that we feel, and still feel, are “Fed resistant”- Hard Assets. Join the resistance movement: Buy Stuff.
Bring Back Alan
I never thought I would ever say this but I was thinking the other day how I long for the days of Alan Greenspan as Fed Chairman. Don’t get me wrong, I think that his arrogance and wrong- headed thinking rank right up there with the worst of the Fed Chairman. The Maestro’s long diatribes ranged from the appropriateness of adjustable rate mortgages, to the shape of the oil futures curve. One thing that he did however was couch the Fed intentions to always shelter the capital markets under a cover of obfuscation. Our most recent Fed Chairs feel no compulsion to “fake it”, their role is to micro-manage the capital markets and no one should be under any misconceptions otherwise. In fact, the latest Maestro is particularly adamant that the suppression of rates has not necessarily created anything that she can’t handle. Our response to that is: “We Will See”. We were describing the state of markets the other day to someone using the accident victim as an analogy. The capital markets/global economy in 2008/2009 experienced a self-inflicted crash, followed by a near death experience. The expanded role of Central Banks was initially to save the patient. However, their ever expanded duties included administering morphine, gassing up the new car and pulling it around front for the quasi-healthy patient to take another joy ride. The problem is that how many near death experiences can one person have, and no one car crash looks like another. As we have discussed, one would expect a certain amount of Central Bank hubris, given that markets have recovered in such a sharp and unexpected fashion ( who would expect that sub-prime loans are exploding and that AAA CLO’s containing the crummiest of credits are exploding as well). However, markets have a way of acting in very non-linear ways and the belief that macro-prudential market regulation will do the trick ignores the speed at which dislocations can occur. Fade Chairman Yellens woman’s intuition: BUY STUFF
Blurred Supply Lines
The recent movement towards more on-shoring of production as well as the recent explosion in global tensions across a number of borders has gotten us thinking about the security of the global commodity supply chain. Whether it is the Mideast or Asia or Eastern Europe, we are suddenly faced with multiple flash points in what traditionally have been fairly stable regions (Mideast excluded). Combine these tensions with a general global shift towards protectionism, and we could see the focus of commodity purchasing mangers shift from price, to availability of supply at any price. The composition of global trade over the past 15 years has occurred against the backdrop of a benign political and social environment. This subsequently has afforded commodity end users the luxury of longer, more responsive global supply lines. However, in a post crisis world, there have been several important shifts which potentially threaten the accommodative nature of the existing supply chain. One shift has been the emphasis on the part of producers to produce more profitably coincident with their inability to tap global capital markets. Another important shift has been the move towards resource nationalism with countries impeding the export of raw materials in favor of providing more value added at the country level (Indonesia, South Africa, etc.). Both of the aforementioned have the combined affect of reducing the availability of supply. Juxtapose these developments against the climate that exists on the political and geo-political fronts and we feel we have the beginnings of what could be a new worry: availability of supply at a reasonable price. Buy Stuff and maybe some warehouse space
I have been thinking a lot about anchors lately. Not to get too nautical here, but my thoughts have centered on the anchors, or perceived anchors we currently see all around us. The front end of the Treasury Curve anchored by the various forms of QE, the attempt to anchore investor expectations by all global central banks, the lack of any attempt by those in Washington to provide any kind of anchor to the credit worthiness of the U.S. Government, the complete lack of anchor associated with any fiat currency. Maybe what got me thinking in this vein was an interview with former Fed Chairman Alan Greenspan. The wide ranging interview, which mostly consisted of trying to box the former chair into some critique of current Fed policy, stood out for two divergent points that were made by the Maestro. When asked about the difficulty with stepping away from Central Bank balance sheet management, Greenspan stated that “it really is not that difficult, it is merely a bookkeeping entry”. The fact that the Fed could conjure up $4Trillion in reserves, and just as easily un-conjure a like amount speaks to the anchorless world in which we live. However, the former Chairman was not done there. When asked about the presence of a Bitcoin bubble, he responded ” I don’t understand where the backing is… there is no intrinsic value”. Buy real anchors(Stuff) Sell perceived anchors(paper).
Investing in a De-Americanized World
We were awestruck by the recent amount of ink spilled regarding the potential for the U.S. Dollar to lose its reserve currency status. Commensurate with the well deserved global piling on were comments by Xinhua ( the Chinese State News Agency) in which they stated that “It is perhaps a good time for the befuddled world to start considering building a de-Americanized world”. When we say we were awestruck, our sense of awe was derived principally from our bewilderment as to why people lavished such safe have status on a currency with such inherent and obvious flaws. While it is true that all fiat currencies are not without their own warts, it was gratifying to at least begin to hear some dissonance as to the gold plated status of the dollar. The biggest question that investors have to address after this latest boondoggle is: Does this latest impasse represent an inflection point for peoples views on the dollar, and if so, what are the investment implications? We are obviously in the camp that feels that there will be a slow pivot away from the dollar, and as a result proactive investors need to position themselves appropriately. Instead of considering a de-Americanized world, perhaps we should start thinking about what assets benefit from a de-dollarized world: Buy Stuff Sell Paper.
Bond Market: Handle with care
Back in November, we discussed the Nassim Talib concept of anti-fragile as it related to the U.S. Treasury Market. We described a Treasury Market which has been manipulated, shaped and coddled by the Federal Reserve and thus been rendered more unstable. Well, the action over the last several weeks provides us with fresh evidence of this instability. The comments that the Chairman made, post FOMC meeting, seemed to smack of micro-management as he described a situation whereby the Fed would either add to, or subtract from, its current asset purchase plan depending on whether its target variables are being met or exceeded. We all know that conventional monetary policy works with a definitive lag, we were however surprised to hear that this highly unconventional monetary policy has an almost immediate feedback loop. We don’t wish to belabor a point, but this latest round of bond market upheaval, in our opinion, is directly related to a diminished lack of credibility afforded by the Bond Market to the Central Bank. The process of micromanaging the Treasury curve to ensure stability has finally reached its apex, and the most recent instability in the market is the byproduct. In our opinion, this instability in rates should begin to translate into a severe dislocation in the dollar as well.
The most recent backup in rates across the long end of the U.S. Treasury curve has prompted much speculation as to the exact cause. The general group -think credits the strength in the U.S. economy, particularly the housing market, as the most likely culprit. However, we would argue that the sharp rise in yields that we have experienced over the past several weeks have really been driven more by the Fed’s ambiguous comments as to the ultimate disposition of their burdensome balance sheet. Chairman Bernanke’s May 22nd testimony was particularly troublesome to the Treasury Market, as it introduced the possibility that the Fed reserves the right to resurrect QE at any time should conditions warrant, even in the event that near term tapering might be soon forthcoming. The subtle message to the market was ‘ we may take away the punch bowl, but at the slightest hint of market DT’s, that punch bowl will be right back’. While the stock market enjoyed such overt support for market “calm”, the Treasury Market seemed to convulse at the message sent by a Central Bank so seemingly obsessed with healthy ( a.k.a. rising) capital markets. We recently spoke to the burgeoning credibility gap that the Fed is creating with such comments, and we believe that the rise in rates substantiates the Treasury Markets increasing distrust. Some in the gold market have commented that the movements in gold reflect an increasing/decreasing trust in fiat currencies. We would maintain that, much like Gold, interest rates are now becoming a barometer for the Treasury Markets view on the soundness/saneness of Central Bank policy.
What should happen doesn’t , What could happen might
We read this quote recently from someone that covers the platinum industry in South Africa. This quote specifically referred to the cutbacks in production that producers were forced to rethink by the Government, in spite of economics which dictate that these, and other , cuts take place. Essentially, when looking at the platinum industry in South Africa, and elsewhere, any analysis is torn between the pragmatic and the dogmatic. Government represents the dogmatic side, arguing for full employment, and a maximization of indigenous mineral rents. Industry, on the other hand, represents the pragmatists which emphasize profit and shareholder value maximization. In a perfectly capitalistic world, pragmatism would far surpass dogma, however it would appear that the environment in South Africa dictates otherwise. As we have discussed in earlier blogs, the capital markets have weighed in on how they view this particular battle playing out in South Africa.
This battle of dogma versus pragmatism got us thinking about the Fed and the effectiveness of the various QE’s. The dogmatic Fed believes that low interest rates are the single greatest cure for what ails the global economy. In their mind, low rates: drive asset prices which in turn drive spending which in turn ultimately drives employment gains. The pragmatic Fed also understands that, above all else, their greatest influence must be manifest in general psychology (business and investor). However, the pragmatic Fed also probably understands that this influence is tenuous at best. Increasing amounts of the same medicine, somewhat counter-intuitively, undermines their ability to continue to affect this psychology. This diminished influence will prove critical, particularly in the event of another six sigma event ( you know, the ones we get every few years).
Risk On- More Risk On
We were waxing nostalgic recently for the bygone days of risk on-risk off. Our affinity for such periods does not stem from some kind of masochistic love for extreme volatility or a desire to feed our inner trader, but rather we miss the days when people actually gave some credence to the latent risks that still exist out there. While markets may ” climb a wall of worry”, todays’s markets prefer to leave the worrying to the Central Bankers and focus solely on the climbing part. It never ceases to amaze us how quickly perception changes in markets. It seemed like only yesterday we were dealing with a budgetary crisis which threatened to push us into another recession. However, today I read an analysis which argued that the Treasury Market, and the economy, should be able to withstand any Fed tapering given the shrinking budget deficits. While it is true that the sequestration has allowed both sides to make progress on the budget, it was only supposed to be a stop-gap measure designed to get both sides more actively engaged. In fact, Moodys just commented on the lack of real discussions, saying that the U.S. is risking another downgrade if no real progress is made on budgetary talks. While a downgrade may be irrelevant in a world where the Fed is the largest captive buyer, we assume that this will matter at some point to non- Central Bank buyers. It is curious that the more voluminous the talk on deflation becomes, the more amped up the capital markets become. We wonder whether these same markets truly grasp what the ramifications of a deflationary spiral would mean, particularly in the context of a still over-leveraged global economy.